ITEM 2-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Throughout this Quarterly Report on Form 10-Q, we refer to Carrols Restaurant
Group, Inc. as "Carrols Restaurant Group" and, together with its consolidated
subsidiaries, as "we", "our" and "us" unless otherwise indicated or the context
otherwise requires. Any reference to "Carrols" refers to our wholly-owned
subsidiary, Carrols Corporation, a Delaware corporation, and its consolidated
subsidiaries, unless otherwise indicated or the context otherwise requires.
We use a 52-53 week fiscal year ending on the Sunday closest to December 31. The
fiscal years ended January 1, 2012 and January 2, 2011 each contained 52 weeks
and the three and nine months ended September 30, 2012 and October 2, 2011 each
contained thirteen and twenty-six weeks, respectively.
Introduction
We are a holding company and conduct all of our operations through our direct
and indirect subsidiaries and have no assets other than the shares of capital
stock of Carrols, our direct wholly-owned subsidiary. The following MD&A is
written to help the reader understand our company. The MD&A is provided as a
supplement to, and should be read in conjunction with our Consolidated Financial
Statements and the accompanying financial statement notes appearing elsewhere in
this report, our Current Report on Form 8-K filed on November 8, 2012 and our
Annual Report on Form 10-K for the year ended January 1, 2012, as amended. The
overview provides our perspective on the individual sections of MD&A, which
include the following:
Company Overview-a general description of our business and our key financial
measures.
Recent and Future Events Affecting Our Results of Operations-a description of
recent events that affect, and future events that may affect, our results of
operations.
Operating Results from Continuing Operations-an analysis of our results of
continuing operations for the three and nine months ended September 30, 2012
compared to the three and nine months ended October 2, 2011, respectively,
including a review of material items and known trends and uncertainties.
Liquidity and Capital Resources-an analysis of historical information regarding
our sources of cash and capital expenditures, the existence and timing of
commitments and contingencies, changes in capital resources and a discussion of
cash flow items affecting liquidity.
Application of Critical Accounting Policies-an overview of accounting policies
requiring critical judgments and estimates.
Effects of New Accounting Standards-a discussion of new accounting standards and
any implications related to our financial statements.
Forward Looking Statements-cautionary information about forward-looking
statements and a description of certain risks and projections.
Company Overview
We are one of the largest restaurant companies in the United States and have
been operating restaurants for more than 50 years. We are the largest Burger
King franchisee in the world and have operated Burger King restaurants since
1976. As of September 30, 2012, we operated 572 Burger King restaurants in 13
states. On May 30, 2012, we acquired 278 company-owned restaurants from Burger
King Corporation ("BKC"), which we refer to as the "acquired restaurants". Our
restaurants operated prior to the acquisition are referred to as our "legacy
restaurants". Our former indirect wholly-owned subsidiary, Fiesta Restaurant
Group, Inc., which we refer to as "Fiesta", was spun off by us to our
stockholders on May 7, 2012, which we refer to as the "spin-off". The results of
operations and cash flows of Fiesta are presented as discontinued operations in
our consolidated financial statements for all periods presented. The discussion
in our MD & A is focused on our continuing Burger King restaurant operations.
The following is an overview of the key financial measures discussed in our
results of operations:
• Restaurant sales consist of food and beverage sales, net of discounts, at
our restaurants. Restaurant sales are influenced by changes in comparable
restaurant sales, menu price increases, new restaurant openings and
closures of restaurants. Restaurants are included in comparable restaurant
sales after they have been open for 12 months. For comparative purposes,
the calculation of the changes in comparable restaurant sales is based on
a 52-week year.

• Cost of sales consists of food, paper and beverage costs including
packaging costs, less purchase discounts. Cost of sales is generally
influenced by changes in commodity costs, the sales mix of items sold and
the effectiveness of our restaurant-level controls to manage food and
paper costs.

• Other restaurant operating expenses include all other restaurant-level
operating costs, the major components of which are royalty expenses paid
to BKC, utilities, repairs and maintenance, real estate taxes and credit
card fees.

• Advertising expense includes all promotional expenses including
advertising payments paid to BKC based on a percentage of sales as
required under our franchise agreements.

• General and administrative expenses are comprised primarily of
(1) salaries and expenses associated with corporate and administrative
functions that support the development and operations of our restaurants,
(2) legal, auditing and other professional fees and (3) stock-based
compensation expense. Historical general and administrative expenses are
shown net of allocations to Fiesta for periods prior to the spin-off.
Amounts charged under a transition services agreement with Fiesta
subsequent to the spin-off are recorded as an offset to general and
administrative expenses and were $1.5 million and $2.6 million in the
three and nine months ended September 30, 2012, respectively.

• EBITDA and Adjusted EBITDA. EBITDA and Adjusted EBITDA are non-GAAP
financial measures. EBITDA represents net income (loss) from continuing
operations, before provision (benefit) for income taxes, interest expense
and depreciation and amortization. Adjusted EBITDA represents EBITDA as
adjusted to exclude impairment and other lease charges, acquisition and
integration costs, stock compensation expense and loss on extinguishment
of debt. We exclude these items from EBITDA when evaluating our operating
performance and believe that Adjusted EBITDA provides a more meaningful
comparison than EBITDA of our core business operating results, as well as
with those of other similar companies that may have different capital
structures. Management believes that EBITDA and Adjusted EBITDA, when
viewed with our results of operations calculated in accordance with GAAP
and our reconciliation of Adjusted EBITDA to net income (loss) from
continuing operations, provide useful information about our operating
performance and period-over-period growth, and provide additional
information that is useful for evaluating the operating performance of our
core business without regard to potential distortions. Additionally,
management believes that EBITDA and Adjusted EBITDA permit investors to
gain an understanding of the factors and trends affecting our ongoing cash
earnings, from which capital investments are made and debt is serviced.
However, EBITDA and Adjusted EBITDA are not measures of financial
performance or liquidity under GAAP and, accordingly, should not be
considered as alternatives to net income (loss) from continuing operations
or cash flow from operating activities as indicators of operating
performance or liquidity. Also, these measures may not be comparable to
similarly titled captions of other companies. For a reconciliation between
net income (loss) from continuing operations and EBITDA and Adjusted
EBITDA see page 27.

EBITDA and Adjusted EBITDA, have important limitations as analytical tools.
These limitations include the following:

• EBITDA and Adjusted EBITDA do not reflect our capital expenditures,
future requirements for capital expenditures or contractual commitments
to purchase capital equipment;
• EBITDA and Adjusted EBITDA do not reflect the interest expense or the
cash requirements necessary to service principal or interest payments
on our debt;
• Although depreciation and amortization are non-cash charges, the assets
that we currently depreciate and amortize will likely have to be
replaced in the future, and EBITDA and Adjusted EBITDA do not reflect
the cash required to fund such replacements; and
• EBITDA and Adjusted EBITDA do not reflect the effect of earnings or
charges resulting from matters that our management does not consider to
be indicative of our ongoing operations. However, some of these
charges (such as impairment expense) have recurred and may reoccur.
• Depreciation and amortization primarily includes the depreciation of fixed
assets, including equipment, owned buildings and leasehold improvements
utilized in our restaurants and the amortization of franchise rights and
franchise fees.
• Impairment and other lease charges are determined through our assessment
of the recoverability of property and equipment and intangible assets by
determining whether the carrying value of these assets can be recovered
over their respective remaining lives through undiscounted future
operating cash flows. A potential impairment charge is evaluated whenever

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events or changes in circumstances indicate that the carrying amounts of these
assets may not be fully recoverable. Lease charges are recorded for our
obligations under the related leases for closed locations net of estimated
sublease recoveries. We currently do not have any lease charges accrued for
closed locations at September 30, 2012.
• Interest expense consists primarily of interest expense associated with
our 11.25% Senior Secured Second Lien Notes due 2018 (the "Notes"),
borrowings under our prior Carrols LLC senior secured credit facility and
the amortization of deferred financing costs. There have been no
borrowings under our new senior credit facility in 2012.

On May 30, 2012, we completed the acquisition of 278 of BKC company-owned Burger
King restaurants, which we refer to as the "acquisition", for a purchase price
consisting of (i) a 28.9% equity ownership interest, (ii) $3.8 million for cash
on hand and inventory at the acquired restaurants and (iii) $9.4 million of
franchise fees and $3.8 million for BKC's assignment of its right of first
refusal on franchisee restaurant transfers in 20 states ("ROFR") pursuant to an
Operating Agreement, which we refer to as the "operating agreement", dated as of
May 30, 2012 with BKC. The amount for the ROFR is payable in quarterly payments
over five years and the first quarterly payment of $0.2 million was made at
closing on May 30, 2012. We also entered into new franchise agreements pursuant
to the purchase and operating agreements and entered into leases with BKC for
all of the acquired restaurants, including leases for 81 restaurants owned in
fee by BKC and subleases for 197 restaurants under terms substantially the same
as BKC's underlying leases for those properties. Pursuant to the operating
agreement, we also agreed to remodel 455 Burger King restaurants to BKC's 20/20
restaurant image, including 57 restaurants in 2012, 154 restaurants in 2013, 154
restaurants in 2014 and 90 restaurants in 2015. The Series A Convertible
Preferred Stock, which we refer to as the "Series A Preferred Stock", issued to
BKC was subject to restrictions limiting the conversion of the Series A
Preferred Stock to an amount of shares not to exceed 19.9% of the outstanding
shares of our common stock as of the date of issuance (the "issuance
limitation"). The removal of the issuance limitation was approved by our
stockholders at our 2012 annual meeting.

The results of operations of the acquired restaurants have been included in our
operating results from May 31, 2012, the day following the closing of the
acquisition.
Refinancing of Outstanding Indebtedness
On May 30, 2012, we issued $150.0 million of 11.25% Senior Secured Second Lien
Notes due 2018 and entered into a new senior credit facility that provides for
up to $20.0 million of revolving credit borrowings (which was undrawn at
closing). The net proceeds from the issuance of the Notes were used to (i) repay
all outstanding borrowings under the prior Carrols LLC senior credit facility of
$64.8 million (ii) pay $12.1 million related to the acquisition of the acquired
restaurants from BKC and (iii) fees and expenses related to the offering of the
Notes. The remainder of the net proceeds will be used together with anticipated
operating cash flow to fund the restaurant remodeling obligations committed to
in connection with the acquisition, and to fund future payments to BKC for the
ROFR. Interest expense associated with this indebtedness, including the
amortization of deferred financing costs, will be approximately $4.5 million in
the remainder of 2012.
Spin-off of Fiesta Restaurant Group, Inc.
On April 16, 2012, our board of directors approved the spin-off of Fiesta, which
through its subsidiaries, owns and operates the Pollo Tropical and Taco Cabana
restaurant brands. In connection with the spin-off, on April 24, 2012, we and
Carrols entered into several agreements that govern our post spin-off
relationship with Fiesta, including a Separation and Distribution Agreement, Tax
Matters Agreement, Employee Matters Agreement and Transition Services Agreement.
Amounts earned by us under the Transition Services Agreement were $1.5 million
and $2.6 million in the three and nine months ended September 30, 2012,
respectively and are expected to be approximately $4.0 million for all of 2012.

Fiesta filed with the Securities and Exchange Commission (the "SEC") a Form 10
registration statement, File No. 001-35373, as amended, which included as an
exhibit an information statement which describes the spin-off. The Form 10
registration statement, which registered the common stock of Fiesta under the
Securities Exchange Act of 1934, as amended, was declared effective by the SEC
on April 25, 2012.
On May 7, 2012, we completed the spin-off of Fiesta in the form of a pro rata
dividend of all of the issued and outstanding common stock of Fiesta to Carrols
Restaurant Group's stockholders whereby each stockholder of Carrols Restaurant
Group's common stock of record on April 26, 2012 received one share of Fiesta
common stock for every one share of Carrols Restaurant Group common stock held.
As a result of the spin-off, Fiesta is now an independent company whose common
stock is traded on The NASDAQ Global Select Market under the symbol "FRGI."
Carrols Restaurant Group's common stock continues to trade on The NASDAQ Global
Market under the symbol "TAST."

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The historical operating results of Fiesta prior to the spin-off are included in
our operating results as income or loss from discontinued operations for all
periods presented.

Operating Results from Continuing Operations
Three Months Ended September 30, 2012 Compared to Three Months Ended October 2,
2011
The following table sets forth, for the three months ended September 30, 2012
and October 2, 2011, selected operating results from continuing operations as a
percentage of restaurant sales for all of our restaurants, our legacy
restaurants and the acquired restaurants:

Since the beginning of the third quarter of 2011 through the end of the third
quarter of 2012, we have closed nine restaurants. On May 30, 2012 we acquired
278 restaurants from BKC.
Restaurant Sales. Total restaurant sales in the third quarter of 2012 increased
87.1%, to $169.5 million from $90.6 million in the third quarter of 2011.
Restaurant sales in the third quarter of 2012 for the acquired restaurants were
$75.1 million. Comparable restaurant sales for our legacy restaurants increased
6.2% resulting from an increase in customer traffic of 3.6% and a 2.6% increase
in average check, which resulted from a shift in sales mix and the effect of
menu price increases of 1.9% compared to the prior year. This was partially
offset by the closure of nine restaurants since the beginning of the third
quarter of 2011.
Operating Costs and Expenses (percentages stated as a percentage of restaurant
sales for the restaurants being discussed): Cost of sales for all restaurants
increased to 32.1% in the third quarter of 2012 from 29.7% in the third quarter
of 2011. Cost of sales at our legacy restaurants increased to 30.0% in the third
quarter of 2012 from 29.7% in the third quarter of 2011 due primarily to higher
commodity prices (1.0%), including higher beef and pork prices, and higher
promotional sales discounts, offset in part by a favorable sales mix and the
effect of menu price increases taken in the last twelve months of 1.9%. Cost of
sales of 34.8% in the third quarter of 2012 for our acquired restaurants was
higher than our legacy restaurants due primarily to inefficiencies, shrinkage
and higher waste and, to a lesser extend, lower margins on soft drink sales.

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Restaurant wages and related expenses for all restaurants increased to 31.6% in
the third quarter of 2012 from 30.5% in the third quarter of 2011. Restaurant
wages and related expenses for our legacy restaurants decreased to 29.5% in the
third quarter of 2012 from 30.5% in the third quarter of 2011 due to the effect
of higher sales volumes on fixed labor costs and lower medical claim costs
(0.3%). Restaurant wages and related expenses for our acquired restaurants was
34.2% in the third quarter of 2012 and higher than our legacy restaurants due
primarily to our integration efforts including an over-investment in productive
labor of $1.8 million prior to implementing our labor scheduling processes at
the acquired restaurants late in the third quarter and, to a lesser extent, the
effect of fixed labor costs on lower sales volumes relative to our legacy
restaurants.
Other restaurant operating expenses for all restaurants increased to 17.0% in
the third quarter of 2012 from 15.1% in the third quarter of 2011 due primarily
to higher repairs and maintenance expenses associated with the acquired
restaurants including $1.1 million of excess repairs as part of our integration
efforts to address deferred maintenance at these locations, higher BKC royalty
expense at the acquired restaurants, as a percentage of restaurant sales, and
the effect of higher fixed operating cost percentages at the acquired
restaurants due to lower sales volumes at the acquired restaurants compared to
our legacy restaurants.
Advertising expense for all our restaurants increased to 4.6% in the third
quarter of 2012 from 4.2% in the third quarter of 2011 due primarily to our
commitment to BKC, as part of the acquisition, to spend 0.75% of restaurant
sales for additional local advertising in markets that have approved such
additional spending in the second half of 2012. This increase was offset by
advertising credits received from BKC that were associated with 2012 menu
enhancement initiatives. These advertising credits total $5,400 annually per
restaurant for 2012 through 2015. In 2012, $2,700 per restaurant was received in
the first quarter with $900 per quarter to be received in each of the remaining
quarters. For 2013 through 2015 these credits will be received ratably over each
year.
Restaurant rent expense for all restaurants increased to 7.3% in the third
quarter of 2012 from 6.3% in the third quarter of 2011 due primarily to rent
associated with the acquired restaurants which, as a percentage of restaurant
sales, was 8.7% during the third quarter of 2012 reflecting the lower sales
volumes at the acquired restaurants. Rent expense for our legacy restaurants
decreased to 6.2% from 6.3% due to the effect of higher sales volumes on fixed
rental costs.
General and Administrative Expenses. General and administrative expenses
increased $4.6 million in the third quarter of 2012 to $9.3 million and, as a
percentage of total restaurant sales, increased to 5.5% compared to 5.3% in the
third quarter of 2011. This increase was due primarily to $1.9 million of legal
costs related to recent activity pertaining to our outstanding litigation with
the EEOC, additional salaries and other costs for the ongoing operational
oversight associated with the acquired restaurants, and $0.5 million of
incremental integration costs for recruitment, training, travel, meetings and
employee relocation expenses related to the integration of the acquired
restaurants.
Adjusted EBITDA. As a result of the factors above, Adjusted EBITDA decreased
14.9% to $7.1 million in the third quarter of 2012 from $8.4 million in the
third quarter of 2011. Adjusted EBITDA excludes an aggregate of $3.4 million of
integration costs related to the acquired restaurants mentioned above. For a
reconciliation between net income (loss) from continuing operations and EBITDA
and Adjusted EBITDA see page 27.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased to $8.2 million in the third quarter of 2012 from $3.9 million in the
third quarter of 2011 due primarily to the addition of the acquired restaurants
and from point-of-sale systems installed at our legacy restaurants in 2012 and
the second half of 2011.
Impairment and Other Lease Charges. Impairment and other lease charges were $0.1
million in both the third quarter of 2012 and 2011.
Interest Expense. Interest expense increased to $4.5 million in the third
quarter of 2012 from $1.7 million in the third quarter of 2011 due to our
refinancing in the second quarter of 2012. The weighted average interest rate on
our long-term debt, excluding lease financing obligations, increased to 11.25%
in the third quarter of 2012 from 6.7% in the third quarter of 2011 due to the
issuance of the Notes in the second quarter of 2012.
Provision (Benefit) for Income Taxes. The benefit for income taxes for the third
quarter of 2012 was derived using an estimated effective annual income tax rate
for 2012 of 41.9%, which excluded discrete tax adjustments. In the third quarter
of 2012 we recorded a valuation allowance of $1.4 million against deferred tax
assets associated with certain state net operating loss carryforwards which
reduced the benefit for income taxes in the third quarter. We also had other
discrete tax adjustments which increased the benefit for income taxes by $0.2
million in the third quarter of 2012. The provision for income taxes for the
third quarter of 2011 was derived using an estimated effective annual income tax
rate for 2011 of 76.6%, which excluded discrete tax adjustments which reduced
the provision for income taxes by $0.1 million in the third quarter of 2011. The
2011 effective tax rate is higher than 2012 due to a disproportionate level of
employment related tax credits in 2011 relative to the pretax loss for the
period.

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Net Income (Loss) from Continuing Operations. As a result of the above, net loss
from continuing operations for the third quarter of 2012 was $6.7 million, or
$0.29 per diluted share, compared to net income from continuing operations in
the third quarter of 2011 of $0.4 million, or $0.02 per diluted share. The net
loss from continuing operations in the third quarter of 2012 included charges as
discussed above, which reduced earnings by $0.20 per diluted share. These
included the acquisition integration costs of $3.4 million ($0.09 per diluted
share) and the EEOC litigation related costs of $1.9 million (or $0.05 per
diluted share). In addition, tax expense included a charge for a valuation
allowance against deferred tax assets of $1.4 million (or $0.06 per diluted
share).
Nine Months Ended September 30, 2012 Compared to Nine Months Ended October 2,
2011
The following table sets forth, for the nine months ended September 30, 2012 and
October 2, 2011, selected operating results from continuing operations as a
percentage of restaurant sales for all of our restaurants, our legacy
restaurants and the acquired restaurants::

In addition to the 278 acquired restaurants, since the beginning of 2011 through
the third quarter of 2012 we opened two restaurants, one of which was relocated
within its market area, and closed, excluding the relocated restaurant, twelve
restaurants.
Restaurant Sales. Restaurant sales in the first nine months of 2012 increased
44.6% to $377.0 million from $260.8 million in the first nine months of 2011 due
to sales at the acquired restaurants of $102.5 million and an increase in
comparable restaurant sales for our legacy restaurants of 7.0%, from both
. . .